Tuesday, 18 August 2015

The economic policies of Jeremy Corbyn have come under widespread criticism.
This exceeds the level of scrutiny of his policies; many of his critics do not
seem to have troubled themselves to read his key
policy document. It also be far exceeds the level of scrutiny devoted to any
of his leadership rivals.

This is not surprising. All major sections of big business in Britain and in
the western economies as a whole are committed to austerity policies. The
economic consensus in favour of austerity arises not from economics textbooks or
any appraisal of economic history, even recent history such as the stagnation
from 2010 to 2012 and the rise in the deficit that resulted. Austerity is the
consensus because it represents the interests of these dominant sections of the
economy and therefore society.

This explains the assault on Corbynomics, which
we should expect to intensify if he wins the leadership of the Labour Party.

Therefore it is important to address these arguments. The BBC’s economics
editor Robert Peston, led
the way and was closely followed by the Financial
Times’ economics editor Chris Giles. Academics have weighed in, with one
characteristic contribution from John
Van Reenen at the LSE. There are important nuances between these and other
critics of Corbynomics but they have common central arguments. All summaries are
reductive and readers are encouraged to review these pieces themselves. But the
central argument is this:

· the British economy is dependent on foreign capital inflows
· instructions from government to the Bank of England undermine the Bank’s
independence
· the flow of international capital on which Britain depends will halt as
investors take fright
· as a result, the currency will fall an interest rates will rise
· this will cause inflation and reduce investment, the very opposite of
Corbynomics’ aim
· And, the existing £375bn in Quantitative Easing cannot be used as an
example as this may be temporary and almost solely focused on the purchase of
government bonds (gilts)

It is noteworthy that the critique begins with capital flows and rests on the
absolute power of financial markets to set exchange rates and interest rates.
These are real and powerful forces and cannot be ignored. But the dominance of
finance capital in British society is so great it influences opinion so that the
argument ‘There Is No Alternative’ appears to have great weight. The weight of
this argument would be lesser in countries such as Germany, or Sweden, or even
the US.

There is no denying the British economy is increasingly dependent on inflows
of overseas capital, setting new lows last year. This is not simply or even
primarily the chronic UK trade deficit, which has persistently oscillated around
2% of GDP in recent. As Fig.1 below shows it is the sharp deterioration in the
primary income account which has caused a sharp and unsustainable rise in the
current account deficit. It has swung from small surplus in mid-2013 to a
deficit of 3% or more of GDP in recent quarters.

Fig. 1 Current account balance, % GDP & components

Source: ONS

The primary income account and its components is shown in Fig.2 below. There
are two key points to be highlighted. The first is the very large and persistent
deficit on portfolio investment, ranging between 5% and 10% of GDP. This is a
net outflow of capital representing the far greater propensity of British
capital to invest overseas because of higher returns.

But this persistence means that portfolio investment outflows are not
responsible for the recent sharp deterioration in the primary investment account
and therefore in the current account as a whole. The balance of Direct
Investment has swung from a surplus to a deficit and accounts for the
deterioration in the external accounts. This has taken place while corporate
taxes have been cut and while the last government was claiming that ‘Britain was
open for business’.

Fig.2 Primary income account and components

Source: ONS

It is a remarkable fact that the government’s repeated assertions that its
policies are promoting growth and investment are rarely challenged although they
are so clearly false. George Osborne has repeatedly asserted that his policies
are successfully promoting investment. Specifically he and his supporters have
argued that the cut in Corporate Tax rates from 28% to 18% is
and will promote Foreign Direct Investment. Fig.3 below shows that FDI
inflows have been declining over the medium-term, even while corporate taxes
have been cut and ‘business-friendly’ policies have been adopted.

Fig.3 Net FDI Inflows and components

Source: ONS

It is no accident that the sharp deterioration in the external accounts
occurred in mid-2013. As SEB has
shown elsewhere the Coalition government halted new austerity measures and
even slightly increased government spending in order to get re-elected.
Borrowing, particularly for housing and other consumption was encouraged. Unless
government borrowing was to increase, or were to companies face higher taxes,
then the increase in borrowing had to be sourced from overseas.

In order to get re-elected the government encouraged an unsustainable
borrowing binge. It now proposes to deal with this crisis with renewed
austerity, which will cause an economic crisis. Overseas investors have a
diminishing appetite for investment in Britain because it is a slow-growth,
low-investment economy. Low British investment levels become self-reinforcing.

The entire criticism of Corbynomics can be shown to be a case of what
Freudian psychoanalysts term projection. It
is the current policy which has dramatically increased the dependence of the
British economy on overseas capital inflows. And the only remedy offered is
renewed austerity. This is simply ‘TINA’ (there is no alternative) purportedly
from the perspective of the all-powerful dealing room floors of the City.

One of the weakest points of the critique is that it rests on the outlandish
proposition that the Bank of England retains credibility. The independent Bank
has presided over the biggest ever financial crash in Britain and the longest
recession. Throughout most of 2008 the MPC
was discussing the need to raise interest rates, even as the economy had
already begun its biggest slump since the 1930s. The Bank’s record on growth
since independence has been markedly worse than the rest of the post-WWII
period. It has also persistently missed its own inflation target. It has a spectacularly
bad forecasting record for growth and inflation even in the short-term. It
is even questionable how independent the Bank is on decisive matters as the bank
bailout of 2008 was clearly a government plan, with Bank
officials still delivering speeches about ‘moral hazard’ (pdf).
The superiority of Corbynomics

The weakness of his opponents arguments do not by themselves mean that
Corbynomics can succeed. But this has been dealt with in
a previous post.

Instead, it is important to state why Corbynomics is superior to the
alternative, based on economic fundamentals. The critics argue that government
intervention may have been a necessary evil at the time of the banking crisis
(and unsurprisingly acceptable to bankers) but that government intervention in
the real economy is unacceptable.

This turns economic reality on its head. The returns to productive investment
in the economy are far higher than government bond yields. The rate of return
for UK companies is currently around 12%, and never fell below 8% even in the
depth of the recession as shown in Fig.4 below.

Fig.4 Net rate of return to Private Non-Financial Corporations, %

Source; ONS

By contrast the British government can borrow at extraordinarily low rates to
fund investment, as shown in Fig.5 below. At the time of writing the yield on 10
year UK gilts is 1.8% which is a fraction of the rate of return on private
investment.

Fig. 5 UK 10 year gilt yields

Source: Bank of England

The objection raised at this point (see Peston in particular) is that there
are no projects or sectors where such returns are additionally available,
otherwise the private sector would be investing in them. But this criticism is
misplaced and only serves to highlight the innate superiority of state-led
investment over that of the private sector.

On exactly the same investment, the returns available to the public sector
are higher.

To demonstrate this, take the obvious case of housebuilding. Private builders
estimate an average construction cost per home of £100,000 in Britain, and a
sale price of £175,000 to cover their fees, borrowing costs and of course
profits (National Association of Home Builders estimates).

Yet government can build exactly the same home at exactly the same price. It
will naturally have far lower borrowing costs than any private sector company.
But it is the returns to government which are massively higher. This is because
government obtains tax revenues which of course are unrecoverable by any private
sector developer. This will be both income taxes on all labour employed, plus
tax revenues on all consumption financed by that income, and all other
consequential taxes. There is also a benefit to government finances from the
increase in economic activity arising from lower social security payments.

The UK Treasury estimates that for every £1 increase in economic activity
there will be a 75p boost to government finances, 50p in tax revenues and 25p in
lower social security payments*. As a result the net cost of home construction
is just £25,000 (after all returns are included) while it now has an asset with
market price of £175,000. Employment and a home have bene created and a
genuinely affordable rent is easily possible.

The superiority of the public sector is even greater in a strategic sense.
Government can direct investment to the most-needed or most productive sectors
of the economy, energy, transport, infrastructure and education, in addition to
housing in a coordinated fashion. The vastly greater returns to the government
means that it is not even the main direct beneficiary of the investment. It is
private firms who benefit most, at least in a direct sense, from investment in
transport, education, infrastructure and so on. But the key condition is that
they not be lowed to act as a brake on investment, as they are currently.

The trading response of financial operators is entirely predictable.
Irrespective of their political views their purpose is to make money. The dire
warnings against the 2009 Labour stimulus Budget that interest rates would soar
was actually followed by a sharp fall in interest rates. Investors were more
likely to get their money back from a government whose economy was growing
rather than contracting. (The political response maybe another matter, but that
is a separate discussion on the levers a radical government would have to use).

Government investment in the productive sectors of the economy yields very
high returns, much higher than the interest payable on government debt.
Corbynomics has offered a range of options to achieve that increase in
investment. All of them are preferable to current policies because they can
work.